The thoughts of Michael Cadwallader. Coffee loving, history book reading, Cheshire man.

Saturday, November 11, 2006

Economic Warnings - Rumbling On

Early in the summer, I made a fewcomments on the down-turning economy. Most of the analysis still stands up now. Mervyn King had to raise interest rates later in the summer, and has done so again last week. My opinion in May was that a 'shock' interest rate rise, or at least the threat of one, would have been a good thing at cooling off inflation, there and then. Instead, the Commitee dillied and dallied, and have now had to raise rates twice, with a further one on the cards thanks to continued house price mania and an increasing RPI.

The oil prices have, however, been a bit harder to predict. Seemingly on an inexorable rise before, they peaked during the Israel-Hezbollah conflict. But with a, thankfully, damp squib of a hurricane season over, and after the passing of the American 'driving season', September saw speculators exiting the market very quickly.

I am not going to attempt to write that I foresaw this happening, Jerome K. Jerome once said that 'it is always the best policy to speak the truth - unless, of course, you are an exceptionally good liar', well I'm a terrible liar. So hands-up. But, shorn of speculators, oil is now stripped down to its fundamentals. And, with continued economic growth, no matter how small, oil is headed on an upwards trajectory, with $80 barrel crude a possibility within the next couple of years.

What has been slightly more surprising is the performance of the stock market. It has actually held up very well, with the Dow making a record high and the FTSE climbing over 6200. Whatsmore, all news seems to be good news to the markets. The record corporate profits are probably responsible for a large part of the buoyancy, but the market now seems to be rather overpriced, for my liking.

The main worry for the markets has to come from the state of the American economy. It seems to be wobbling quite badly at the moment. And, historically speaking, when the US slips into a recession, Britain usually follows.

Perhaps 2001 was an exception to this, but, more than likely, that was avoided by Gordon Brown's Keynesian public spending binge. But let's not bash poor old Keynes. Sure, he gave politicans justification for spending huge amounts of public money. It's also true, however, that he called for spending to be reduced when the economy was doing well. So, politicans claimed to be following Keynes when they were spending their way out of a recession. But once world-improving politicans have a taste for spending money, they continue to spend. After all, so the theory goes, if the medicine has worked, why not swallow the whole bottle?

Enough of the digression, let's get back to the question about the US economy. Well, it does seem to be dangerously close to teetering over the brink. An inverted yield curve does not look promising. Then there's the housing market, still looking for a soft landing. The use of housing equity withdrawal, treating the house as an 'ATM machine', has been a major factor in fuelling consumer spending. The reduction in GDP can be at least partly attributed to this. But, Neither of these factors make a recession inevitable. And, many economists do not seem to be especiallyperturbed:

The effects of the housing correction will be entirely contained within the housing sector," says Mike Englund, chief economist of Action Economics. Corporate balance sheets are stronger than they've been in years, with U.S. companies sitting on $600 billion in cash. Interest rates are stable, and may decline. Falling energy prices are easing the burden on energy-intensive industries like chemicals and airlines.

So, all in all, the economy is at a worrying crossroads but is not yet a dead-man walking. And, my suspicion that as soon as the US economy looks to be heading south the Fed will turn up its printing press, still stands. Although another interest rate rise in the new year would suggest that inflationiary worries still persist. Either way, the road ahead is full of obstacles, one false move from the Fed and we are staring either a recession or increasing inflation in the face.

My advice is the same as ever. And, I don't mind being as annoying as Mogambo on this subject. Quite simply - buy some gold!

2 Comments:

I agree with what you are saying about oil, it now seems to pretty much down to supply and demand.

The scary thing about oil is that the predicted oil peak, which appeards to be set for around 2015-2020, is going to coincide with the retirement of the baby-boomer generation.

Personally, I don't think peak oil on its own is going to bring down western civilisation, but if it coincides with other serious economic problems then we are at least going to see a very big recession.

The fact that developing countries don't have to comply with Kyoto is also likely to hasten the arrival of peak oil.

Someone (memory fails me) recently said: "I agree with the energy optimists that technology will eventually pull us through... the key word being "eventually." This idea that oil markets will have a Goldilocks soft landing, though, and that the gusher days of yesteryear will roll back around is just plain silly."

When we reach peak oil, probably within 15 years, I think it will severely hit the financial markets and economies of the world. With debt and baby boomers thrown into the mix, the phrase 'perfect storm', comes to mind.

But, a lot of peak oil advocates see us descending into some sort of pit of regression. Calling themselves 'survivalists', they believe that people will have to take up gardening "if they want to feed themselves", and other assorted nonsense. It seems to me that these are the modern versions of William Morris, who believed that agrarian Medieval England was some sort of utopia.

Personally, I am very bullish on alternatives to oil. With technologies like diesel derived from farming waste or from coal, looking very promising. I am certain that the storm will be ridden out......eventually.